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Small businesses are carefully monitoring the status of their local banks, on alert for any indication that their payroll and other accounts might be safer at the megabanks, which are widely perceived as being “too big to fail.”
Their concern comes in the wake of the failures of Silicon Valley Bank and First Republic Bank earlier this year. Large unrealized losses in the securities and mortgage portfolios of these banks were “held to maturity” and therefore not marked to market. Such losses, due to the sharp rise in U.S. interest rates, led to the takeover of both banks, arranged and assisted by the FDIC.
Investors and depositors have since been scrutinizing the asset/liability mismatches and unrealized losses in the portfolios of small and midsized banks.
While U.S. government officials publicly state that depositors need not worry about the safety of their bank account, these same leaders have declined to commit that all deposits will be insured above the $250,000 limit on FDIC insurance.
“ Firms with fewer than 500 employees create 1.5 million job per year and account for 64% of new jobs in the U.S.”
The U.S. has around 4,150 banks. Six of them are known as “GSIBs,” or globally systemically important banks, and another five are SIFI banks, or systemically important financial institutions. About 80 banks have assets in excess of $20 billion and within that group, 35 or so have assets topping $100 billion. Silicon Valley Bank and First Republic Bank were among the 20 largest U.S. banks.
More than 4,000 community banks around the country have assets under $20 billion. Such banks provide real-estate, commercial and industrial loans primarily to smaller businesses. According to the FDIC, community banks account for 36% of all small-business loans and 31% of farm-sector lending.
Small and midsize banks take deposits from small businesses in connection with operating their payroll and business checking accounts. In turn, these small businesses are responsible for a substantial portion of America’s economic activity and job creation. Firms with fewer than 100 employees account for more than a third of the country’s private sector staff and produce a quarter of its gross output. Firms with fewer than 500 employees create 1.5 million job per year and account for 64% of new jobs in the U.S., according to the Small Business Administration.
In order to retain depositors in the current economic environment, small and midsized banks have been forced to pay accountholders much higher interest rates. At the same time, they must guard against potential runoffs of deposits by shrinking their assets to the extent feasible. However, they are reluctant to sell many of the securities and mortgages in their portfolios because they would recognize unrealized losses.
“ Small and midsized banks have been pulling back from existing and new loan commitments. ”
In a logical response to this bind, small and midsized banks have been pulling back from existing and new loan commitments. According to the Small Business Lending Index of Biz2Credit, small banks granted about 20% of loan applications in February 2023, compared to approving about half of loan applications in early 2020 before the COVID-19 pandemic.
If current conditions continue, small businesses will find it much more challenging to obtain debt financing. In many cases, these businesses rely on local bank-lending as their primary source of credit. Although FICO score and digital platforms are used heavily for consumer loans, small-business loans require in-person due diligence, judgement and are time consuming and costly to originate. Small- and midsized banks are equipped to play this vital role.
By contrast, large banks do not find this process to be cost-effective for relatively small loans. In February 2023, large banks approved just 14% of loan applications from small business, according to the Small Business Lending Index of Biz2Credit.
It is in America’s national interest to bolster the viability of small and medium-sized banks. Some have proposed that all bank deposits be insured by the FDIC, or that the limit on FDIC insurance be lifted to over $1 million for any depositor. Others have argued that this expansion of FDIC insurance would produce moral hazard — shielding bank executives from the consequences of making overly risky loans and investments.
Recently, the FDIC offered a legislative proposal to provide much higher levels of deposit insurance to transactional accounts used by small businesses to fund their payrolls. Even a business with 50 employees will typically maintain deposits of more than $250,000 at a local bank to fund its weekly payrolls. Most of these transactional accounts for small businesses are non-interest-bearing, so they are especially attractive to smaller and midsize banks.
“ Level playing field is needed to compete with ‘too big to fail’ financial giants. ”
I strongly support this proposal because it would give small and midsized banks a more level playing field in competing with their bigger counterparts to attract and retain these business checking accounts. This proposal would go a long way to help stabilize the banking system so it can continue to lend to worthy small firms across the country.
At the same time, Congress could mitigate concerns about moral hazard by limiting the deposit insurance expansion to payroll and other business transaction accounts that do not pay interest at banks below $20 billion in assets.
Meanwhile, the few megabanks deemed too big to fail are accumulating deposits and market power. JPMorgan Chase
JPM,
alone received $50 billion in new deposits from anxious savers this spring. Small- and midsized banks are at a substantial competitive disadvantage in attracting transactional accounts from local businesses and have been forced to pull back on their lending to these businesses.
To move toward a more level playing field, Congress should provide unlimited FDIC deposit insurance subject to three conditions: (1.) only on non-interest-bearing checking accounts, (2.) at U.S. banks with less than $20 billion in assets and (3.) limited to accounts of small businesses as defined by the FDIC.
Robert Pozen is a senior lecturer at MIT Sloan School of Management and formerly President of Fidelity Investments.
Also read: More banks could collapse like SVB did because the system favors those ‘too big to fail’
Plus: Fed’s Kashkari says U.S. is doomed to more bank bailouts unless Congress makes key reform
